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Wednesday, August 31, 2011

How Much Revenue from Limiting Deductibility?

One unattractive aspect of having certain expenditures be deductible in the U.S. tax code is that any deduction is worth more to someone in a higher tax bracket. Thus, when it comes to typical deductions like the mortgage interest deduction, the deduction for state and local taxes, the deduction for charitable contributions, or the deduction for large out-of-pocket health care expenditures, someone in a 35% tax bracket saves 35 cents off their tax bill for each $1 of deductible expense, while someone in a 15% tax bracket saves only 15 cents off their tax bill for each $1 of deductible expense. Of course, the two-third of taxpayers who don't have enough of these specific expenses to make it worthwhile to itemize their deductions just take the standard deduction, and get nothing extra off their tax bill for these expenses.

Proposals are always kicking around to reduce deductibility, by limiting the tax savings from a deductible expense to say, 28% or even 15%. How much revenue might such proposals raise?

What about limiting deductibility to 28%?
Daniel Baneman, Jim Nunns, Jeffrey Rohaly, Eric Toder, Roberton Williams estimate the revenue to be raised from a proposal to limit deductibility to 28% in a recent paper for the Tax Policy Center. They write (footnotes omitted):

"To measure the revenue and distributional implications of these proposals, the analysis considers two baselines: current law and current policy. “Current law” is the standard baseline that official revenue estimators at the Joint Committee on Taxation use to score tax proposals. It assumes that tax law plays out as it is currently written. Most important, that means that the 2001–2010 income and estate tax cuts expire at the end of 2012 and that temporary relief from the alternative minimum tax (AMT) expires at the end of 2011. The “current policy” baseline assumes that Congress permanently extends all provisions in the 2011 tax code (except the 2 percent reduction in Social Security payroll tax) as well as AMT relief, indexed for inflation after 2011. ...

[A] proposal from the Obama Administration ... would limit the benefit of itemized deductions to 28 percent. ..  Thus, for example, an additional $100 of itemized deductions would save a taxpayer in the 35 percent bracket only $28 rather than $35. The 28 percent limitation on itemized deductions would raise an estimated $288 billion over the next ten years compared with current law ...  Relative to current policy, the proposal would raise $164 billion.

The 5.3 million affected households in the top quintile would see their taxes go up by an average of about $2,900. The average tax increase for the 697,000 affected households in the top 1 percent would be about $13,300. Almost all of the tax increase—99.8 percent—would fall on households in the top quintile of the income distribution—those with cash incomes greater than $111,000. ...  The top 1 percent would bear 61 percent and the top 0.1 percent would pay a little more than one-third."

What about limiting deductibility to 15%?
The Congressional Budget Office does a regular report called "Reducing the Deficit: Spending and Revenue Options." In the March 2011 report, Revenues--Option 7 is ""Limit the Tax Benefit of Itemized Deductions to 15 Percent." CBO estimates that this change could raise $1,180 billion over the next 10 years relative to current law, which is roughly four times as much as the 28% limitation would raise. The CBO doesn't do a distributional analysis, but this change would only affect those who already itemize deductions, and would have by far its largest effect on those with higher incomes.


Of course, there are justifications for the existing tax deductions, and reasons and history behind the justifications, and interest groups behind it all. But in a situation where all the meaningful options for long-term deficit reduction are going to be painful in one way or another, limiting deductibility has some advantages. It would raise revenue from those with higher incomes without increasing the marginal income tax rates, or part of the revenue could even be used to reduce the top marginal rates. Limiting deductibility also reduces the role of the federal government in certain aspects of the economy like providing incentives for greater mortgage borrowing. It should be in the mix of possibilities.

For a related post several weeks ago, see "Tax Expenditures: One Way Out of the Budget Morass."



Tuesday, August 30, 2011

Noriel Roubini (aka "Dr. Doom") on Exchange Rates, China, and U.S. Investment

Nouriel Roubini, sometimes nicknamed "Dr. Doom," is interviewed by Tom Keene of Bloomberg News at the Milken Institute Global Conference in May. An edited and shortened transcript of the interview is available (with free registration) in the Milken Institute Review (Third Quarter, pp. 65-74). Or you can watch the interview here. Some snippets:

On currency adjustment: 
"Exchange rate determination is really a beauty contest about which currency is the “least ugly,” and this changes depending on relative growth concerns, fiscal policy, financial stability, sovereign debt, interest rate policies, etc. At the moment, all the major currencies have reasons to be weaker. The trouble is, not all currencies can be weak. The currencies that should be depreciating are those of the U.S., U.K. and other countries that went bust in the financial bubble, and now need export growth to make up for anemic domestic demand during the period of balance sheet retrenchment. ... Countries running current account surpluses can keep on accumulating reserves, and thereby prevent the appreciation of their currencies. By contrast, countries with deficits eventually run out of foreign exchange reserves, or the bond vigilantes impose discipline. The one exception is the United States: because the dollar is the major reserve currency, we can run larger deficits for longer. If the
dollar didn’t have reserve status, it would have collapsed a long time ago."

On the need for rebalancing China's economy: 
"In China today, half of GDP is in the form of fixed investment, while consumption is only 35 percent – and falling. That is not sustainable because no country can productively invest half its GDP for very long. Historically, every case of over-investment – the Soviet Union, East Asia in the 90s – has ended in a hard landing."


On the more rapid economic recovery in Asia: 
The recovery in the Asian emerging markets has been a “V” [rather than a “U”] because their financial fundamentals were much sounder and they don’t have balance sheet problems comparable to the U.S. and Europe. In some countries, though, that recovery’s now leading to overheating.
Are they in control of their own destiny? Not if China shadows the dollar and everybody else shadows China; they are effectively adopting U.S. monetary and credit policies. As a result, there’s been excessive money growth, excessive foreign exchange intervention. You’re seeing overheating in credit that is spilling out as price pressure in the equity, commodity and real estate markets. And
therefore Asia is in danger of both goods and asset inflation."

Why the U.S. needs a weaker dollar: 
"Tim Geithner and others say they’re in favor of a strong dollar. But we actually need a weaker dollar, maybe 15 percent on a trade-weighted basis. Think about it rationally. Because of the asset bubble collapse, domestic demand is going to be anemic. So in order to maintain growth even close to potential, we need to reduce our trade deficit. How do you reduce this trade deficit? We have to have more private and public savings – but that’s going to slow down domestic demand even more. Therefore we need a weaker exchange rate to gradually improve the trade balance."

On U.S. firms sitting on their cash: 
"While the balance sheets of government and financial institutions are damaged, the corporate sector is in excellent shape. Corporations have used the crisis to cut costs, especially labor costs. They’re highly profitable and productive: earnings are going to be surprising. They are sitting on $2 trillion in cash in the U.S. alone. But they are not spending it. And even if they start to spend, it’s not clear why they’d choose to invest in slow-growing advanced economies rather than fast-growing emerging markets. One reason they’re not spending more is excess capacity: roughly a quarter of industrial
capacity is currently not used. Why would you want to do a lot of investment where there is excess capacity?"

Monday, August 29, 2011

The Coming Urban World

A standard pattern in economic growth is that a rise in per capita GDP is accompanied by a larger share of the population living in urban areas. Thomas Nechyba and Randall Walsh describe the U.S. experience in a Fall 2004 article on "Urban Sprawl" in my own Journal of Economic Perspectives: "Only slightly more than 5 percent of the U.S. population lived in urban areas in 1790, a figure that had tripled by 1850 and surpassed 50 percent by 1920. By the 2000 Census, 79 percent of all Americans lived in areas designated as “urban” by the Census Bureau.

 But the trend toward urbanization is international, as the UNFPA noted in its 2007 State of World Population report on the theme: "Unleashing the Potential of Urban Growth." "In 2008, the world reaches an invisible but momentous milestone: For the first time in history, more than half its human population, 3.3 billion people, will be living in urban areas."


The McKinsey Global Institute has published a couple of interesting reports on global urbanization recent months. "Urban world: Mapping the economic power of cities," came out in March 2011.
"Half of the world’s population already lives in cities, generating more than 80 percent of global GDP today. But the urban economic story is even more concentrated than this suggests. Only 600 urban centers, with a fifth of the world’s population, generate 60 percent of global GDP. In 2025, we still expect 600 cities to account for about 60 percent of worldwide GDP—but the cities won’t be
the same. ... Today, major urban areas in developed regions are, without doubt, economic giants.
The 380 developed region cities in the top 600 by GDP accounted for 50 percent of global GDP in 2007, with more than 20 percent of global GDP coming from 190 North American cities alone. ... Over the next 15 years, the makeup of the group of top 600 cities will change as the center of gravity of the urban world moves south and, even more decisively, east. ... By 2025, we expect 136 new cities to enter the top 600, all of them from the developing world and overwhelmingly (100 new cities) from China. These include cities such as Haerbin, Shantou, and Guiyang. But China is not the only economy to contribute to the shifting urban landscape. India will contribute 13 newcomers including Hyderabad and Surat. Latin America will be the source of eight cities that include
CancĂșn and Barranquilla."

Here are predictions from McKinsey on the world's top 25 cities in 2025, ranked by GDP, per capita GDP, GDP growth, and Total population. Cities in blue are in the developing world, and they dominate the last two columns.





Cities in economic terms are bundles of economies of scale and agglomeration. For example, cities can act as a hub for economies of scale in production and lower transportation costs. They can provide a density of potential workers, employers, and customers, in a way that reduces risk for all parties and enables a greater division of labor. They can facilitate spillovers of information and skills, and serve as a breeding ground for entrepreneurship. However, the power of  scale and agglomeration have a negative side, as well. The cost of living and especially housing is typically higher in cities. Agglomeration can lead to pollution and stress on infrastructure, including congested transportation facilities and issues in providing water and electricity. Urban networking can can also facilitate criminal activity. Cities often create extremes of wealth and poverty rubbing shoulders, which can create political and social stresses. (For an exposition of cities along these lines, see Edward L. Glaeser's article "Are Cities Dying" in the Spring 1998 issue of the Journal of Economic Perspectives, which is too far back to be freely available on-line, but can be downloaded if you have access to JSTOR).

The McKinsey Global Institute makes this point as well: "As urban centers grow, they benefit from agglomeration—or economies of scale—that enable many industries and service sectors to have higher productivity than they do in a rural setting. It is also much less expensive to provide goods and services in concentrated population centers. Our research indicates that the cost of delivering basic services such as water, housing, and education is 30 to 50 percent cheaper in concentrated population centers than it is in sparsely populated areas. Very large cities attract the most talent and inward investment, and they are often at the center of a cluster of smaller cities, which creates network effects that spur economic growth and productivity."

But as McKinsey also argues that while huge cities are engines of economic growth, they can become so large that their diseconomies begin to slow them down. The largest future growth may not be in the largest cities: "Contrary to common perception, megacities have not been driving global growth for the past 15 years. In fact, many have not grown faster than their host economies, and we expect this trend to continue. We estimate that today’s 23 megacities will contribute just over 10 percent of global growth to 2025, below their 14 percent share of global GDP today. Instead, we see the 577 fast-growing middleweights in the City 600 contributing half of global growth to 2025, gaining share from today’s megacities."

The McKinsey Global Institute has takes up these issues of how the cities can contribute to growth, but also how the size of cities can limit their growth, in a series of reports, including a February 2009 report on cities in China, and an April 2010 report on urbanization in India. 
The latest report on this subject from August 2011 discusses: "Building globally competitive cities: The key to Latin American growth." A few snippets from the report:

  • "Cities are critical to Latin America’s overall economy. The region’s 198 large cities—defined as having populations of 200,000 or more—together contribute over 60 percent of GDP today. The ten largest cities alone generate half of that output. Such a concentration of urban economic activity among the largest cities is comparable with the picture in the United States and Western Europe today but is much more concentrated than in any other emerging region. China’s top ten cities, for instance, contribute around 20 percent of the nation’s GDP."
  • "Yet Latin America has already won a large share of the easy gains that come from expanding urban populations. Today, many of Latin America’s largest cities are grappling with traffic gridlock, housing shortages, and pollution, all symptoms of diseconomies of scale. For the region’s largest cities to sustain their growth, they need to be able to address challenges not only to their economic performance but also to the quality of life experienced by their citizens, sustainable resource use, and the strength of their finances and governance."
  • "Between 2007 and 2025, we expect the region’s top ten cities to display below-average growth in both population and GDP, while the rest of Latin America’s large cities are likely to expand their populations at an above-average rate. These cities are projected to generate almost 40 percent of the region’s overall growth between 2007 and 2025, almost 1.5 times the growth the top ten cities are expected to generate. What accounts for this shift in the balance of economic power? In Latin America’s largest cities, signs of diseconomies of scale such as congestion and pollution have started to outweigh scale benefits, diminishing the quality of life they can offer citizens and sapping their economic dynamism. At the same time, economic liberalization across the region has reversed the centralizing bias that concentrated economic activity in the largest cities. The more decentralized economic approach has given middleweight cities a boost. These medium-sized urban centers lag behind larger cities in their per capita GDP today, but many have not yet run into the diseconomies of scale faced by larger cities."




Friday, August 26, 2011

Sky-High Textbook Prices--And My Suggested Solution for Intro Economics

High textbook prices are modest problem in the context of soaring costs of higher education, but many of the costs of tuition and room and board are more-or-less concealed from many students, while textbook costs are in their faces and their pocketbooks. According to a recent short story in the Chronicle of Higher Education, 7 in 10 Students Have Skipped Buying a Textbook Because of Its Cost, Survey Finds."  The article refers to a survey done by the U.S. Public Interest Research Group of 1,905 students at a range of 13 campuses. "Separate analyses from the U.S. Public Interest Research Group have found that textbook costs are typically comparable to 26 percent of tuition at state universities and 72 percent of tuition at community colleges."

This evidence basically confirms what has been found by other groups. Back in May 2007, the Advisory Committee on Student Financial Assistance, which produces reports for the U.S. Department of Education,  published “Turn the Page:  Making College Textbooks More Affordable.” Some comments from that report:
  • “Annual per student expenditures on textbooks can easily approach $700 to $1,000 today."
  • "Nearly all the components of college expenses outpaced the CPI from 1987 to 2004 for both two-year and four-year public colleges.. . . Textbook expenses rose far more rapidly than the prices of other commodities nationwide: 107% at two-year public colleges and  109% at four-year public colleges, compared to 65% for the CPI.”
  • “Even after accounting for total grant aid, textbooks and other learning materials appear to be unaffordable for students from low- and moderate-income families at both two- and four-year public colleges.”
  • “Students today see the traditional textbook for many undergraduate courses as a disposable resource, not a long-term reference book, in part because frequent edition updates can render it obsolete quickly, and the digital era has changed attitudes toward the nature of printed material.”
In July 2005, the GAO published a report called College Textbooks: Enhanced Offerings Appear to Drive Recent Price Increases" (GAO-05-806). Some comments from the report:

  • “Increasing at an average of 6 percent per year, textbook prices nearly tripled from December 1986 to December 2004, while tuition and fees increased by 240 percent and overall inflation was 72 percent."
  • "While many factors affect textbook pricing, the increasing costs associated with developing products designed to accompany textbooks, such as CD-ROMs and other instructional supplements, best explain price increases in recent years."
  • "U.S. college textbook prices may exceed prices in other countries because prices reflect market conditions found in each country, such as the willingness and ability of students to purchase the textbook."

Economics textbooks are not exempt from these trends, of course. Take a look at prices for the best-selling and best-known introductory economics textbooks. A copy of the full-year, micro and macro version will typically list at more than $200, although students can often get discounted copies at sellers like Amazon.com for about $170-$180.

My solution is my own introductory textbook, "Principles of Economics." The second edition of this text is out this fall through Textbook Media, Inc. The pricing works this way: $17 for access to an online e-textbook which has search, notes, and chat options, but that can't be printed; $22 for the e-textbook along with the ability to print out PDF files of the chapters; and $33 for the e-textbook along with a black-and-white printed softcover version of the book.  Textbook Media is a small company. It has no sales force to knock on the doors of professors and take them to lunch. It sponsors no junkets. The book is printed in black and white. But it does have e-textbook functionality, a workbook of problems and answers, a test bank, and some other add-ons. If you want a micro or a macro split, they are available. Of course, I think the content and exposition of the book is excellent on its own merits. But given the issue of soaring textbook prices, the price alone should make it worth a look.

ADDED: Arnold Kling at Econlog responds with a tough-minded comment about college faculty in a post titled "But Why Would Greg Mankiw Adopt?": "I can see why students would have an incentive to adopt a cheaper textbook. But professors, and particularly professors who author competing textbooks, have no such incentive. And they are the ones who drive adoption."















Thursday, August 25, 2011

Unrequited Economic Optimism from the Congressional Budget Office?

The Congressional Budget Office has just published its August 2011 "The Budget and Economic Outlook: An Update." Although the language of the report is concise and unemotional, many elements of the report seem to me to carry a message that the worst of our economic travails are over. However, the report also points out that its economic forecasting and analysis was completed in early July, and the economy has had some worse-than-expected news since then. Here, I'll start with optimism, and then finish with the more grim recent economic news.

What about housing prices?
The CBO believes that the bursting bubble of housing prices has just about run its course. This figure shows two housing price series: Federal Housing Finance Agency and the Standard & Poor's/Case-Shiller index. As CBO explains: "The FHFA index covers only homes financed using mortgages that have been purchased or securitized by Fannie Mae or Freddie Mac. TheS&P/Case-Shiller index also includes sales financed with mortgages that do not conform to the size or credit criteria for purchase by Fannie Mae or Freddie Mac."  But the CBO is predicting that for the country as a whole, housing prices are soon going to start rising again.

What about employment?
The good news here is that the bad news is diminishing. The first figure shows the ratio of unemployed people to job openings. After the 2001 recession, the ratio of unemployed to job openings rose to almost 3:1, before falling back to 1.5:1 in about 2007. Then during the recession, the ratio took off and reached almost 7:1, before now falling to about 4.5:1. The second figure shows net job gains in recent months, which aren't large, but are better than a sharp stick in the eye. The third figure shows that the unemployment rate peaked at 10.1% in November 2009, but was down to 9.1% by July 2011. The CBO projections are for the unemployment rate to fall modestly to 8.5% by fourth quarter 2012, and then to fall more rapidly.




What about business investment?
Much of business investment just replaces worn-out capital. Net investment takes total investment and subtracts out the depreciation of existing capital, so that it is only looking at the addition to the capital stock. During the recession, many firms were postponing this new investment, but the CBO predicts that a bounceback is near.

What about real GDP?
I quote: "For the 2013–2016 period, CBO projects that real GDP will grow by an average of 3.6 percent a year, considerably faster than potential output. That growth will bring the economy to a high rate of resource use (that is, completely close the gap between the economy’s actual and
potential output) by 2017." As with the unemployment rate, the forecast here is for modestly good news in 2012, followed by much better news in 2013 and after.

Is all this too optimistic?
The CBO makes a point of emphasizing that its economic forecasts were completed in early July. Since then, the European debt crisis has exploded, the federal government seemed unable to grapple seriously with debt issues and raising the debt ceiling, the stock market fell, economic statistics were released suggesting that the recession was deeper than previously believed, and more. Some of the figures above have little break in the line between present data and the forecast: the forecasts are based on the earlier uncorrected data, which after revision was worse than previously known.

At least for me, it's a natural reaction to look at these CBO forecasts that economic turnaround and catch-up are around the corner and roll my eyes in disbelief. Pessimism seems so worldly-wise; optimism seems so naive. But if the CBO is correct, whoever is elected president in 2012 is going to look like a miracle worker for the economy--mainly because by 2013 the U.S. economy will finally be escaping the sluggishness of the Long Slump and experiencing a robust economic recovery. 


Wednesday, August 24, 2011

Less Migration Within the United States

Raven Molloy, Christopher L. Smith, and Abigail Wozniak discuss "Internal Migration in the United States" in the Summer 2011 issue of my own Journal of Economic Perspectives. They begin (parenthetical citations omitted throughout:

"The notion that one can pick up and move to a location that promises better opportunities has long been an important part of the American mystique. Examples abound, including settlers making the leap over the Appalachians prior to the Revolutionary War; the nineteenth century advice to “Go west, young man, go west” often attributed to newspaper editor Horace Greeley; John Steinbeck’s tale of the Joad family heading west in the 1930s to escape the Dust Bowl in The Grapes of Wrath; and the mid twentieth-century Great Black Migration northward out of the poverty of sharecropping and low-wage labor in the South. Indeed, it is widely believed that internal migration rates in the United States—that is, population flows between regions, states, or cities within a country—are higher than in other countries. This belief is not exactly wrong, but reality is more complex. For example, the Dust Bowl migrants of the 1930s were not representative of their time, but rather were an exceptional case during a period of markedly low internal migration. While the United States has historically had one of the highest rates of internal migration in the world by many measures, citizens of some other countries—including Finland, Denmark, and Great Britain—appear equally mobile. Moreover, internal U.S. migration seems to have reached an inflection point around 1980. As shown in Figure 1, the share of the population that had migrated between states trended higher during much of the twentieth century, with the exception of the Great Depression. However, migration rates have been falling in the past several decades, calling into question the extent to which high rates of geographic mobility are still
a distinguishing characteristic of the U.S. economy."

Molloy, Smith and Wozniak offer evidence that the decline in U.S. mobility is a very broad-based--and not a trend that has been made notably worse by the recent woes in the U.S. economy and housing market. They write: "By most measures, internal migration in the United States is at a 30-year low. Migration rates have fallen for most distances, demographic and socioeconomic groups, and geographic areas. The widespread nature of the decrease suggests that the drop in mobility is not related to demographics, income, employment, labor force participation, or homeownership. Moreover, three consecutive decades of declining migration rates is historically unprecedented in the available data series. The downward trend appears to have begun around the 1980s, pointing to explanations that should be relevant to the entire period, rather than specific to the current recession and recovery—that is, the decline in migration is not a particular feature of the past five years, but has been relatively steady since the 1980s."

They also offer some international comparisons.  They write: "Overall, the secular decline in geographic mobility appears to be specific to the U.S. experience, since internal mobility has neither fallen in most other European economies nor in Canada—with the United Kingdom as a notable exception." But while the most other countries have not been experiencing a decline in mobility, mobility levels in the U.S. continue to be higher than in most places. Here's an illustrative figure:





Tuesday, August 23, 2011

Peter Rossi's Metallic Laws of Policy Evaluation

In an article by Jens Ludwig, Jeffrey R. Kling and Sendhil Mullainathan in the Summer 2011 issue of my own Journal of Economic Perspectives, called "Mechanism Experiments and Policy Evaluations," they introduced me to the "metallic rules" of the eminent sociologist Peter H. Rossi. The rules come from Rossi's 1987 article,“The Iron Law of Evaluation and Other Metallic Rules,” Research in Social Problems and Public Policy, vol. 4, pp. 3–20. The article is pre-web, and the publication is not easily available, but David Roodman at the Center for Global Development tracked down the article a couple of years ago, and posted an excerpt summarizing the rules on his Microfinance Open Book Blog. Rossi died in 2006; a brief obituary and some remembrances from colleagues are available at the website of the American Sociological Association.


Here are Peter Rossi's "metallic rules" of policy evaluation from his 1987 article: 

A dramatic but slightly overdrawn view of two decades of evaluation efforts can be stated as a set of “laws,” each summarizing some strong tendency that can be discerned in that body of materials. Following a 19th Century practice that has fallen into disuse in social science, these laws are named after substances of varying durability, roughly indexing each law’s robustness. 

The Iron Law of Evaluation: The expected value of any net impact assessment of any large scale social program is zero.
The Iron Law arises from the experience that few impact assessments of large scale social programs have found that the programs in question had any net impact. The law also means that, based on the evaluation efforts of the last twenty years, the best a priori estimate of the net impact assessment of any program is zero, i.e., that the program will have no effect.

The Stainless Steel Law of Evaluation: The better designed the impact assessment of a social program, the more likely is the resulting estimate of net impact to be zero.
This law means that the more technically rigorous the net impact assessment, the more likely are its results to be zero—or no effect. Specifically, this law implies that estimating net impacts through randomized controlled experiments, the avowedly best approach to estimating net impacts, is more likely to show zero effects than other less rigorous approaches. 

The Brass Law of Evaluation: The more social programs are designed to change individuals, the more likely the net impact of the program will be zero.
This law means that social programs designed to rehabilitate individuals by changing them in some way or another are more likely to fail. The Brass Law may appear to be redundant since all programs, including those designed to deal with individuals, are covered by the Iron Law. This redundancy is intended to emphasize the especially difficult task faced in designing and implementing effective programs that are designed to rehabilitate individuals. 

The Zinc Law of Evaluation: Only those programs that are likely to fail are evaluated.
Of the several metallic laws of evaluation, the zinc law has the most optimistic slant since it implies that there are effective programs but that such effective programs are never evaluated. It also implies that if a social program is effective, that characteristic is obvious enough and hence policy makers and others who sponsor and fund evaluations decide against evaluation.

Prenatal Inequality


Douglas Almond and Janet Currie discuss "Killing Me Softly: The Fetal Origins Hypothesis," in the Summer 2011 issue of my own Journal of Economic Perspectives. They begin (parenthetical citations deleted throughout):

In the late 1950s, epidemiologists believed that a fetus was a “perfect parasite” that was “afforded protection from nutritional damage that might be inflicted on the mother.” The placenta was regarded as a “perfect filter, protecting the fetus from harmful substances in the mother’s body and letting through helpful ones.” Nonchalance existed with regard to prenatal nutrition. During the 1950s and 1960s, women were strongly advised against gaining too much weight during pregnancy. During the baby boom, “pregnant women were told it was fine to light up a cigarette and knock back a few drinks.” Roughly half of U.S. mothers reported smoking in pregnancy in 1960.

But what if the nine months in utero are one of the most critical periods in a person’s life, shaping future abilities and health trajectories—and thereby the likely path of earnings? This paper reviews the growing literature on the so-called “fetal origins” hypothesis. The most famous proponent of this hypothesis is David J. Barker, a British physician and epidemiologist, who has argued that the intrauterine environment—and nutrition in particular—“programs” the fetus to have particular metabolic characteristics, which can lead to future disease."  

Almond and Currie offer a thoughtful overview of the evidence that a wide array of environmental factors may have long-run effects not only on health, but also on economic outcomes like wages. These environmental factors that can affect fetal development include both extreme situations like famine, but also milder environmental factors like infectious diseases, exposure to pollution, maternal diet, and even severe weather during a pregnancy. Thinking through what constitutes cause-and-effect evidence for these issues often involves a search for a natural experiment. Two of the points they make about the implications of their argument as a whole, several points struck me with particular force:

1) There's a long-standing argument in the social sciences about nature vs. nurture, but arguments over genetic influence are getting a lot more complex these days than what I learned back in grade-school about Gregor Mendel and his pea plants. The current subject of epigenetics explores how the same genes can lead to different characteristics. As Almond and Currie write in this context about fetal effects: "[T]he hypothesized effects reflfl ect a specific biological mechanism, fetal “programming,” possibly through effects of the environment on the epigenome, which are just beginning to be understood. The epigenome can be conceived of as a series of switches that cause various parts of the genome to be expressed—or not. The period in utero may be particularly important for setting these switches."

2) While this literature is still young and growing, it could turn out to be true that one of the most important ways to help children is to help their pregnant mothers. Almond and Currie write: "[O]ne of the most radical implications of the fetal origins hypothesis may be that one can best help children (throughout their life course) by helping their mothers. That is, we should be focusing on pregnant women or perhaps even women of child-bearing age if the key period turns out to be so early in pregnancy that many women are unaware of the pregnancy. Such pre-emptive targeting would constitute a radical departure from current policies that steer nearly all healthcare resources to the sick, i.e., the “pound of cure” approach. That said, the existing evidence is not sufficient to allow us to rank the cost-effectiveness of interventions targeted at women against more traditional interventions targeted at children, adolescents, or adults."

Monday, August 22, 2011

Gains from Emigration

Much of the literature on international migration takes the perspective of the receiving county: for example, how might immigrants into the United States be affecting wages for U.S. citizens or government budgets. The Summer 2011 issue of my own Journal of Economic Perspectives has a three-paper symposium on emigration--that is, looking at international migration from the perspective of the migrants themselves and the sending countries. Here are some highlights:

1) Allowing much higher levels of international migration could provide gains to the migrants themselves that are enormous relative to size of world GDP. Michael A. Clemens offers a striking back-of-the-envelope calculation in "Economics and Emigration: Trillion-Dollar Bills on the Sidewalk?" Clemens writes:

"Divide the world into a “rich” region, where one billion people earn $30,000 per year, and a “poor” region, where six billion earn $5,000 per year. Suppose emigrants from the poor region have lower productivity, so each gains just 60 percent of the simple  earnings gap upon emigrating—that is, $15,000 per year. This marginal gain shrinks as emigration proceeds, so suppose that the average gain is just $7,500 per year. If half the population of the poor region emigrates, migrants would gain $23 trillion—which is 38 percent of global GDP. For nonmigrants, the outcome of such a wave of migration would have complicated effects: presumably, average wages would rise in the poor region and fall in the rich region, while returns to capital rise in the rich region and fall in the poor region. The net effect of these other changes could theoretically be negative, zero, or positive. But when combining these factors with the gains to migrants, we might plausibly imagine overall gains of 20–60 percent of global GDP."


Of course, Clemens goes into considerably more depth in the article, and argues that gains of this magnitude are plausible given the studies that have been done and the current state of knowledge of this area. I would emphasize further that many studies of migration look either at effects on those in the receiving country, or on those in the sending country, but somehow seem to leave out the gains to the migrants themselves--which may well be the dominant part of a broad social welfare calculation.

2) Remittances sent back to their country of origin by migrants now top$300 billion per year. Dean Yang discusses this point in "Migrant Remittances," along with going into more detail on why remittances are sent and how they are used. Yang offers this striking figure comparing the level of remittances over time to official development assistance, foreign direct investment, and portfolio investment. He writes: "But since the late 1990s, remittances sent home by international migrants have exceeded offifi cial development assistance and portfolio investment, and in several years have approached the magnitudes of foreign direct investment flows."

Yang also provides a table showing which countries depend most heavily on remittances, including 22 countries where remittances are more than 10% of GDP. 


3) Brain-drain is a beg-the-question label for a phenomenon whose importance has not been demonstrated. One common concern about rising global migration is whether it will impoverish sending countries through loss of skilled labor. John Gibson and David McKenzie tackle this question in "Eight Questions about Brain Drain."  They write:

The term “brain drain” dominates popular discourse on high-skilled migration, and for this reason, we use it in this article. However, as Harry Johnson (1965, p. 299) noted, the term brain drain “is obviously a loaded phrase, involving implicit definitions of economic and social welfare, and implicit assertions about facts. This
is because the term ‘drain’ conveys a strong implication of serious loss.” It is far from clear such a loss actually occurs in practice; indeed, there is an increasing recognition of the possible benefits that skilled migration can offer both for migrants and for sending countries. Thus, Prime Minister Manhoman Singh of India recently said: “Today we in India are experiencing the benefifi ts of the reverse flow of income,
investment and expertise from the global Indian diaspora. The problem of ‘brain drain’ has been converted happily into the opportunity of ‘brain gain’ ..."
Also, I hadn't known: "The term “brain drain” was coined by the British Royal Society to refer to the
exodus of scientists and technologists from the United Kingdom to the United States
and Canada in the 1950s and 1960s."

Friday, August 19, 2011

Summer 2011 Journal of Economic Perspectives

I'm the managing editor of the Journal of Economic Perspectives, published by the American Economic Association. It's an academic journal, but it's meant to be a journal that's readable by those who have some background in economics--like those who took several undergraduate courses in college in the subject. The AEA makes all of the articles the journal freely available on-line to all, and the Summer 2011 issue is now available.

I'll comment on the specifics of some of these articles over the next week or so, but here's the table of contents for the issue. Again, all of these articles are available on-line at the JEP website.

Symposium: Field Experiments
Mechanism Experiments and Policy Evaluations,” by Jens Ludwig, Jeffrey R. Kling and Sendhil Mullainathan
The Role of Theory in Field Experiments,” by David Card, Stefano DellaVigna and Ulrike Malmendier
Field Experiments with Firms,” by Oriana Bandiera, Iwan Barankay and Imran Rasul

Symposium: Emigration
Eight Questions about Brain Drain,” by John Gibson and David McKenzie
Migrant Remittances,” by Dean Yang

Other Articles

Killing Me Softly: The Fetal Origins Hypothesis,” by Douglas Almond and Janet Currie
Internal Migration in the United States,” by Raven Molloy, Christopher L. Smith and Abigail Wozniak
Retrospectives: Hume on Money, Commerce, and the Science of Economics,” by Margaret Schabas and Carl Wennerlind
Recommendations for Further Reading,” by Timothy Taylor


Longer Global Supply Chains

The Strategy, Policy, and Review Department of the IMF published a paper on "Changing Patterns of Global Trade" on June 15. I think students of economics often get a good sense of how international trade can benefit all nations participating, but at least at the intro level, they often get a less good sense of the actual patterns of international trade. One emphasis of the report is on longer global supply chains. Here are a few patterns and facts.

 1) The share of foreign content embedded in gross exports is rising. 
A country can import certain goods or services, use them in production, and then export them again. The share of foreign value-added in exports measures this process, and it has been steadily rising since the 1970s. Here's a table combining several studies, showing a rise in foreign value-added in exports from 18% in 1970 to 24% in 1990, 27% in 1995, and 33% by 2005.  This is a sign of longer global supply chains and rising global interconnectedness.


2) For some countries, gross exports can be less useful as a measure of what the country produces for export than the domestic value-added content of exports.
This figure shows gross exports as the dark line for each country, and domestic value added as the shaded line--the difference between the two is foreign value-added that is re-exported. For a number of countries like Singapore, Malaysia, and Thailand, there's a big gap between the two. 

3) The rise in foreign value-added in exports varies across countries and across industries. 
Here's a table I compiled out of statistics in the report. In China and Japan, the share of foreign-value added almost doubled from 1995 to 2005--which is a signal of the Asian regional economy becoming much more integrated, with inputs often crossing borders several times at different stages of production. The rise in foreign value-added as a share of total exports is noticeable but lower in the U.S. and Germany. If one looks just at the rise in foreign value-added as a share of exports in the high technology sector, these patterns are even more pronounced.


4) World trade has tripled since the 1950s. 
"World trade has grown steadily since World War II, with the expansion accelerating over the past decade. Despite a post-crisis dip, the current level of world gross exports is almost three times that prevailing in the 1950s (Figure 1). With the exception of commodity-price booms in the 1970s and more recently in 2004-2008, commodity trade accounted for a declining share of this growth, with the share of noncommodity
trade rising to more than 20 percent of global GDP in 2008."


Although the growth in world trade over time looks bumpy but more-or-less continual, the type of trade is changing. The growth in trade in the 1950s and 1960s was often a result of lower tariffs, for example. But in recent years, the growth in trade stems from an increasingly interconnected web of countries, who often are producing increasingly similar products.


5) Trade in higher technology goods has led the rise in international trade.
"The structure of trade has been characterized by a rising share of higher technology goods (Figure 4). The contribution of high-technology and medium-high-technology exports such as machinery and transport equipment increased, whereas that of lower technology products such as textiles declined. Technology
intensive export structures generally offer better prospects for future economic growth. Trade in high-technology products tends to grow faster than average, and has larger spillover effects on skills and knowledge-intensive activities. The process of technological absorption is not passive but rather “capability” driven and depends more on the national ability to harness and adapt technologies rather than on factor endowments."











Thursday, August 18, 2011

High Food Prices and Political Unrest

Marco Lagi, Karla Z. Bertrand and Yaneer Bar-Yam of the New England Complex Systems Institute have a working paper up about "The Food Crises and Political Instability in North Africa and the Middle East." This figure tells the heart of the story. The black line shows the two recent spikes in global food prices, one in 2008 and one in 2011. The vertical red lines show the dates of various food riots and/or civil disruptions, with the number of deaths shown in parentheses.Of course, food prices aren't the only factor in causing such disruptions, but the fact that such riots and disruptions essentially vanished in 2009 and 2010, in the time period between the two price spikes, is nonetheless striking.


Thanks to the Instapundit website for the pointer to this study. I've posted a couple of times recently on the subject of the global spike in food prices in 2008 and again in 2011 (see here and here). I've also posted a couple of times in the last few months on how unemployment and poor economic conditions have contributed to political unrest in the Middle East (for example, here and here).

Where Did S&P Get Its Power? The Federal Government (Of Course)

When Standard & Poor's downgraded the credit rating of the U.S. government on August 5, and the global economy trembled, a natural question is: "Who gave them all this power, anyway?" The same question arises when Fitch announced earlier this week that it would not issue a similar downgrade. The answer to who made the credit rating agencies so powerful is: The federal government. Lawrence White encapsulates the history in the Spring 2010 issue of my own Journal of Economic Perspectives, in an article on "The Credit Rating Agencies." Larry writes: 

"However, a major change in the relationship between the credit rating agencies and the U.S. bond markets occurred in the 1930s. Bank regulators were eager to encourage banks to invest only in safe bonds. They issued a set of regulations that culminated in a 1936 decree that prohibited banks from investing in “speculative investment securities” as determined by “recognized rating manuals.” “Speculative” securities (which nowadays would be called “ junk bonds”) were below “investment grade.” Thus, banks were restricted to holding only bonds that were “investment grade”—in modern ratings, this would be equivalent to bonds that were rated BBB– or better on the Standard & Poor’s scale. With these regulations in place, banks were no longer free to act on information about bonds from any source that they deemed reliable (albeit within oversight by bank regulators). They were instead forced to use the judgments of the publishers of the “recognized rating manuals”—which were only Moody’s, Poor’s, Standard, and Fitch. Essentially, the creditworthiness judgments of these third-party raters had attained the force of law."

"In the following decades, the insurance regulators of the 48 (and eventually 50) states followed a similar path. State insurance regulators established minimum capital requirements that were geared to the ratings on the bonds in which the insurance companies invested—the ratings, of course, coming from the same small group of rating agencies. Once again, an important set of regulators had delegated their safety decisions to the credit rating agencies. In the 1970s, federal pension regulators pursued a similar strategy."

"The Securities and Exchange Commission crystallized the centrality of the three rating agencies in 1975, when it decided to modify its minimum capital requirements for broker-dealers, who include major investment banks and securities firms. Following the pattern of the other financial regulators, the SEC wanted those capital requirements to be sensitive to the riskiness of the broker-dealers’ asset portfolios and hence wanted to use bond ratings as the indicators of risk. But it worried that references to “recognized rating manuals” were too vague and that a bogus rating fifi rm might arise that would promise AAA ratings to those companies that would suitably reward it and “DDD” ratings to those that would not."

"To deal with this potential problem, the Securities and Exchange Commission created a new category—“nationally recognized statistical rating organization” (NRSRO)—and immediately grandfathered Moody’s, Standard & Poor’s, and Fitch into the category. The SEC declared that only the ratings of NRSROs were
valid for the determination of the broker-dealers’ capital requirements. Other financial regulators soon adopted the NRSRO category and the rating agencies within it. In the early 1990s, the SEC again made use of the NRSROs’ ratings when it established safety requirements for the commercial paper (short-term debt) held by money market mutual funds."

"Taken together, these regulatory rules meant that the judgments of credit rating agencies became of central importance in bond markets. Banks and many other financial institutions could satisfy the safety requirements of their regulators by just heeding the ratings, rather than their own evaluations of the risks of the bonds."

White goes on to discuss how the NRSRO category has evolved over time, and how Congress more-or-less bludgeoned the Securities and Exchange Commission into allowing some additional NRSROs in the last decade. His article, written in 2010, also points out that one reason why the housing bubble spread through mortgage-backed securities and into the banking system was that the NRSRO's like Standard & Poor's gave some of that debt a tremendously misguided AAA rating. Far too many banks and bank regulators just accepted that rating, although S&P and the other credit rating agencies had no particular history or expertise in evaluating these somewhat complex financial instruments based on subprime mortgage debts. White and others have long argued that while it's perfectly fine to have firms which sell their expertise and opinions about the riskiness of bonds, there's no reason to anoint some of them in such a way that banks and bank regulators legally outsource judgment and prudence to them.

Maybe S&P is wrong to downgrade the U.S. credit rating. But after it whiffed so spectacularly and totally missed the riskiness of the subprime-related mortgage backed securities, it's seems a bit unsporting to turn around and criticize them for being too vigilant now. And if the U.S. government doesn't like the power wielded by S&P--well, it has only itself to blame for bestowing so much of that power in the first place.



Wednesday, August 17, 2011

Can Bernanke Unwind the Fed's Policies?

The Federal Reserve has taken five main policy steps since the financial crisis started to become apparent in late 2007. I supported each of those five steps when they were taken, given the economic situation at the time. But the recession and financial crisis were largely over in June 2009, even if what followed has been an unpleasantly stagnant recovery. The Fed needs to be clear that as conditions warrant, it will be willing to unwind its earlier policies. Thus, when the Fed Open Market Committee announced last week on a 7-3 vote that it would extend its near-zero federal funds interest rates for the next two years, it seemed to me a misstep.  Narayana Kocherlakota, who moved from a position as professor of economics at the University of Minnesota to become President of the Minneapolis Federal Reserve, took the unusual step of explaining publicly why he dissented, and even recording a short video clip of his explanation, which is posted at the Minneapolis Fed website.


But I'm getting ahead of the story. Here are the Fed's five main policy steps since 2007.

1) From May 2006 through September 2007, the federal funds interest rate was about 5%. As the financial crisis began to become apparent in fall 2007 and as the recession started in December 2007, the Fed cut the federal funds rate to 2% by April 2008, where it remained until September 2008. This change can be thought of as the standard Fed reaction to a recession. As Rick Mishkin, who was a member of the Fed Board of Governors at the time, notes an article in the Winter 2011 issue of my own Journal of Economic Perspectives, even in late summer 2008 mainstream forecasters like the Congressional Budget Office were predicting only a short, shallow recession. Rick wrote: " In summer of 2008, when I was serving on the Federal Reserve Board of Governors, there was even talk that the Fed might need to raise interest rates to keep inflation under control."

2) When the financial crisis hit with hurricane force in September 2008, the Fed then took the federal funds target rate down to near-zero. As noted earlier, at its August 9 meeting last week, the Open Market Committee voted to keep this interest rate target for two more years, at which time the policy of a near-zero federal funds rate would have lasted about five years. 

3) Starting in late 2007, the Fed created a veritable alphabet soup of lending agencies to provide short-term credit lines to banks, other financial institutions, and players in key credit markets. These include: the Term Auction Facility (TAF); the Term Securities Lending Facility (TSLF); the Primary Dealer Credit Facility (PDCF); the Asset-Backed Commercial Paper Money; the Market Mutual Fund Liquidity Facility (AMLF);
the Commercial Paper Funding Facility (CPFF); the Money Market Investor Funding Facility (MMIFF); the and Term Asset-Backed Securities Loan Facility (TALF). For a readable overview of these efforts aimed at teachers of economics,  this is a good starting point. From my point of view, the key fact about all these agencies is that they have all been closed down. Thus, I consider them a success. They helped to assure that short-term credit was available during a financial crisis, and then they went away.

4) The Fed started buying mortgage-backed securities early in 2009. At this time, in the depths of the financial crisis, the high level of uncertainty over what these securities were truly worth was in danger of making the market for these securities illiquid, which in turn could have made the financial crisis even worse. As the New York Fed explains: "The FOMC directed the Desk to purchase $1.25 trillion of agency MBS [mortgage-backed securities]. Actual purchases by the program effectively reached this target. The purchase activity began on January 5, 2009 and continued through March 31, 2010. ... On August 10, 2010, the FOMC directed the Desk to keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency MBS in longer-term Treasury securities. As a result, agency MBS holdings will decline over time."

5) The Fed started buying and holding new Treasury debt. The Fed has always held some Treasury debt as part of its normal operations, and in particular as part of carrying out its open market operations and buying and selling bonds. But that amount swelled from about $480 billion back in summer 2008 to about $1.6 trillion now. The Federal Reserve now holds more in U.S. Treasury debt than the China and Japan combined. While the plan to purchase more Treasury debt known as QE2 (that is, "quantitative easing part 2") officially stopped at the end of June, as noted a moment ago, the Fed is now moving from holding mortgage-backed securities to holding Treasury debt, in such a way that its overall holdings of financial securities does not decline.  

Overall, here's where the Fed stands in unwinding the crisis-driven policies enacted since 2007. The many short-term lending facilities have been phased out. The ownership of mortgage-backed securities is being phased down. What is not yet being phased down are the ultra-low interest rates and buying Treasury securities. I'm not brash enough to say just when these policies should be reversed, but I do know this: A central bank can't just keep pumping out money and credit until  unemployment is back to normal levels and hearty growth has resumed. At that point, the central bank has overreacted, potentially by a lot. When the Fed decides that it is time to change these policies, the U.S. probably won't be at full employment and resurgent growth--and so its decision is certain to be controversial.


Here's a graph showing the effective federal funds interest rate since the 1950s, using the ever-helpful FRED website at the St. Louis Fed. Notice that when recessions (the shaded bars) occur, the Fed typically cuts this interest rate, but then when recovery has begun, it raises the rate again. But now the federal funds rate has been at a rock-bottom near zero for more than two years, and in its August 9 meeting, the Federal Open Market Committee voted to leave the rate near-zero until summer 2013. Kocherlakota of the Minneapolis Fed explained his dissent from the policy this way: "I believe that in November [2010], the Committee judiciously chose a level of accommodation that was well calibrated for the prevailing economic conditions. Since November, inflation has risen and unemployment has fallen. I do not believe that providing more accommodation—easing monetary policy—is the appropriate response to these changes in the economy."





From an outsider's point of view, it sure looks as if the Federal Reserve action at its August 9 meeting was a response to headlines from the week before: headlines about the difficulties in hashing out an agreement to raise the federal borrowing ceiling, headlines about Standard & Poor's downgrading the credit rating of the federal government, headlines about the stock market falling.  But monetary policy decisions setting expectations for the next couple of years shouldn't be responding to yesterday's headlines.

As one looks at the federal funds interest rate over time, other troubling issues become apparent. One is that the federal funds interest rate has been gradually moving downward, a step at a time, since it was raised sky-high to stop the inflation of the 1970s. With the federal funds rate at near-zero, this process of stepping interest rates lower and lower has now stopped. Another concern is that the Bank of Japan has run a near-zero interest rate for more than a decade, while failing to stimulate its economy. There is a possible theoretical argument--far from proven, but still a concern--that an economy can get stuck in a situation with near-zero interest rates and stagnant growth. In this kind of model, explained for example by James Bullard of the St. Louis Fed, "Seven Faces of `The Peril'",  a central bank can't wait for a full recovery before raising interest rates, because the hyper-low near-zero interest rates are part of what's blocking the economy from resuming growth.


I wouldn't advocate a sharp or immediate rise in the federal funds interest rate. But I would have voted with Kocherlakota against committing to two more years of near-zero rates. After all, part of what encouraged so much overborrowing in the years leading up to the financial crisis was that the Fed kept interest rates so low for a couple of years after the end of the 2001 recession. The answer to a financial crisis rooted in overborrowing is not to encourage the next wave of overborrowing! The Fed should be thinking about when and how it could get the federal funds target rate up into the 1-2% range--which after all seemed a reasonable interest rate when the economy was in an actual recession back in 2008.

The Federal Reserve buying Treasury bonds is another tough issue. Officially, the Fed's QE2 program of purchasing Treasury securities finished at the end of June, although as noted earlier, the Fed is still using money freed up by winding down its mortgage-backed securities to buy Treasury bonds. Back during World War II, which was fought largely with borrowed money, the mission of the Fed was to keep interest rates low so that federal borrowing costs could stay low. But in 1951, the Fed announced that it was done with that mission, and would instead focus on growth and low inflation. After a battle of bureaucracies, the Fed won its independence. (For an overview and discussion of what happened in the 1951 agreement, one useful starting point is this issue from the Richmond Fed in 2001.)

Having the Fed buy Treasury debt starting in 2009 during the worst of the financial crisis and its aftermath was a fully defensible decision. I sometimes say that it's generally a bad idea to shoot torrents of water at high speed through an office building--but if there's a fire, it's a policy that can make sense. During an emergency, steps that wouldn't make sense at other times sometimes need to be taken. But the recession has now been over for a couple of years. If the U.S. government wishes to run continuing large deficits, it needs to start facing the economic consequences of doing so. The Fed is already helping the federal government to borrow this money by holding interest rates so low, and in time will probably help the federal government further by creating some inflation to reduce the real value of what has been borrowed. It's time for the Fed to back away from being the actual default buyer for new federal debt. This step doesn't require any big announcement, only that the Fed refrain for now from announcing a QE3 program for buying more Treasury debt. If another financial crisis surfaces, after all, the Fed should try to hold something in reserve.





Tuesday, August 16, 2011

Economic Growth: Why We Need It, What We're Not Doing

Michael Greenstone and Adam Looney put together a background paper for a Hamilton Project conference called "A Dozen Economic Facts About Innovation."

Why is innovation and increased productivity important? Two of the main measurable reasons are how it increases incomes and life expectancy. It may be that the worst economic event to befall the U.S. economy in the last 40 years is not relatively recent shock of the Great Recession, terrible though that has been, but the productivity slowdown that hit in the early 1970s. Greenstone and Looney write: "If TFP [total factor productivity] had continued growing at the pre-1973 trend and that productivity gain were reflected in workers’ compensation, compensation could be 51 percent higher, or about $18 per hour more than today’s average of $35.44 per hour. This calculation highlights that small changes in innovation and annual TFP growth lead to large differences in long-run standards of living."

Economic growth and innovation have also helped to generate longer life expectancies, partly through reductions in  infectious disease, but also through better diets and cleaner water and sanitation. The gains in health have huge value. Kevin Murphy and Robert Topel estimated the long-term value of gains in health in a 2006 article in the Journal of Political Economy (pp. 871-904).From their abstract: "Cumulative gains in life expectancy after 1900 were worth over $1.2 million to the representative American in 2000, whereas post-1970 gains added about $3.2 trillion per year to national wealth, equal to about half of GDP. Potential gains from future health improvements are also large; for example, a 1 percent reduction in cancer mortality would be worth $500 billion." Here's a Greenstone-Looney figure on gains in life expectancy and reductions in infectious disease.


One of the most striking areas of innovation in recent years, of course, is the electronics industry. Here's a graph showing what it would have cost to buy the computing power of an iPad 2 over recent decades. Notice that the vertical scale is a logarithmic graph: that is, it is descending by powers of ten as the price of computing power halves and halves and halves over and over again.

What's to be done to improve the prospects for innovation and economic growth for the future? There is a broad productivity agenda of improving human capital, investing in plant and equipment, and getting America's financial and budgetary problems under control. But there is also a more narrow technology-focused agenda. For example, every politician in the U.S. talks has been talking about the importance of technology for decades--but government spending on research and development has actually been sinking. Corporate spending on R&D has taken up some of the slack, but government R&D is far more likely to be focused on the basic research that generates new industries, not the tightly-focused process companies often use to update their products.

Another issue is to have America's higher education system focus more heavily on the so-called STEM fields: that is, science, technology, engineering, and mathematics. The share of total U.S. degrees being granted in these fields has fallen since the mid-1980s, and compared to other countries, the U.S. higher education system grants a lower proportion of its degrees in STEM fields.


A final issue is to improve the U.S. patent system. There are lots of subtle issues about what kind of innovation deserves a patent, or what doesn't, and how much a patent is really worth in an intellectual property showdown. But at a more basic level, a slow patent system is less useful for everyone--and the time to get a decision from the U.S. Patent Office has been rising.